Credit Hotspot: Brexit

A 'no-deal' Brexit remains a significant risk due to UK political volatility, despite manoeuvres in parliament to try to prevent it. The nature and timing of the UK's exit from the European Union remain uncertain, and the risk that a no-deal departure causes substantial disruption to UK economic prospects is reflected in the Rating Watch Negative (RWN) on the UK's 'AA' sovereign rating.

The increased threat of the UK leaving the EU without an agreement is causing a divergence in investment decisions among UK auto manufacturers. Some companies have announced a potential reduction in their investment, while others are boosting capacity.

The election of Boris Johnson as leader of the UK Conservative Party further increases the risk of a no-deal Brexit, but domestic political outcomes, and therefore the timing and nature of the UK's exit from the EU, are still highly uncertain. Johnson was confirmed as the new party leader on Tuesday following a ballot of party members, and will likely be asked to form a government on Wednesday.

UK challenger banks may be more vulnerable than more established banks to late-cycle and Brexit-related risks. Several challenger banks have grown faster than the market, and faster than GDP, during relatively benign credit conditions in recent years, with performance not yet tested in a downturn.

The resignation of UK Prime Minister Theresa May and the strong showing by the Brexit Party in European Parliamentary elections increases the risk of a no-deal Brexit, but the lack of a parliamentary majority for leaving without a deal could constrain this path. The timing and outcome of the UK's exit remains highly uncertain.

Rated UK transport infrastructure issuers are generally well placed to weather short-term disruption in traffic and trade flows in the event of a "no-deal" Brexit thanks to their robust liquidity positions and financial flexibility. The longer-term impact is more uncertain but weaker macroeconomic factors could reduce traffic, and hurt revenue, EBITDA and financial metrics.

UK pub and leisure issuers are vulnerable among whole business securitisations (WBSs) to a no-deal Brexit due to revenue and cost pressures. Short-term shocks are likely to be offset by stockpiling, comfortable liquidity positions and balance sheet flexibility, but a dampening effect on the UK economy could hurt UK WBS issuers in the medium and long term.

The agreement between the EU and the UK to further extend the process outlined in Article 50 of the Treaty on European Union to 31 October 2019 reduces but does not eliminate the risk of a 'no-deal' Brexit over the next six months. The decision to maintain the RWN on the UK's 'AA' ratings reflects the downside risks associated with a disruptive exit from the EU.

The European Union and the European Investment Bank's 'AAA'/Stable ratings would not be affected by a no-deal Brexit. The EIB is expected to benefit from full replacement of the UK's capital, while short-term risks to the EU budget are manageable.

The BoE's rating reflects its central role in the UK and international financial system. The rating is underpinned by support from the UK sovereign. The near certainty of sovereign support for the BoE derives from its national strategic importance, as well as ownership by the UK Treasury.

With the UK's decision to leave the EU coming to a head, Fitch believes US banks active in Europe are well prepared operationally for any potential outcome, and that Brexit is unlikely to be a ratings or credit issue. US banks have largely updated their legal entity structures to be able to continue to conduct normal business operations and service clients in the UK and EU post Brexit.

Investors in open-ended UK property funds face a growing risk that the funds will prohibit withdrawals by imposing redemption gates as a reaction to market fears that property values will fall because of Brexit.

This action reflects primarily the heightened uncertainty over the outcome of the Brexit process, and an increased risk of a disruptive 'no-deal' Brexit, where the UK would leave the EU without a withdrawal agreement in place. Fitch believes that a 'no-deal' Brexit would lead to substantial disruption to UK economic and trade prospects, at least in the near term.

The tougher operating environment in 2019 is likely to exacerbate liquidity woes of those European airlines that are highly leveraged, prompting defaults or M&A. Recent airlines' bankruptcies, including Flybmi this weekend, and sale attempts support our view that fierce competition, Brexit uncertainty, and oil price and currency volatility will continue to threaten financially weaker airlines and drive further consolidation.

James McCormack, Global Head of Sovereign Ratings at Fitch Ratings, talks about the Brexit negotiations and the implications for the UK economy. He speaks with Manus Cranny on Bloomberg Daybreak: Middle East.

Fitch Ratings’ UK international scale public credit ratings can continue to be used post-Brexit for regulatory purposes in the EU, and its EU international scale public credit ratings can similarly be used for regulatory purposes in the UK, even if there isn’t a Brexit agreement between the UK and EU. We have produced an FAQ document explaining how we have responded to Brexit in order to minimize its impact on the users of our ratings, as well as our business and employees.FAQ: Brexit Impact on Credit Ratings Agencies